Last year was an excellent year for credit throughout the world’s capital markets. Spreads across all levels of the credit spectrum narrowed markedly over the course of the first 11 months of the year. Figures from Standard & Poor’s show that investment grade credit spreads among US non-financials declined from 183 (on January 2) basis points to 128 at the start of December. Bear in mind that investment grade spreads have not been below the 150 level since March 2000! For lower quality paper, the spread compression was even more dramatic, falling from 815 to 461basis points over the same time frame.
A recent study by the Global Fixed Income Research team at Standard & Poor’s, in which they summed the main feature of 2003, concluded that the overall improvements in credit that we did see were driven by a deceleration in downgrades rather than an increase in upgrades. Although downgrades still outpaced upgrades by 2.6 to 1 over the first 11 months of 2003, this figure is significantly lower than the 4.2 to 1 ratio established in 2002.
Across the world 49 ‘fallen angels’ – issuers that are downgraded from investment grade (BBB- and above) to speculative grade (BB+ and below) – were recorded over the time frame, again significantly less than the 74 recorded over 2002. And to re-enforce those findings that it was indeed a marked decrease in bad news rather than a surge in good credit news, Standard & Poor’s point out that the number of ‘rising stars’, ie, those issuers being upgraded from speculative to investment grade, only rose by 9 to 29.
And default rates fell across the world too, most markedly in the EU, where the speculative-grade default rate fell from 6.94% at the end of June to 3.7%. For the first time since February 2002, the EU has a lower speculative grade default rate than the US.
As a note of caution in all the good cheer, the authors draw attention to the fact that with a rising proportion of lower-grade issuance (ie, B- or lower) investors should be alert to the risk of renewed default pressure two to three years ahead. They also feel that the ongoing narrowing in corporate spreads may have priced in quite a rosy economic scenario for 2004, with stronger growth combined with lower inflation and a slight upward movement in benchmark interest rates. Should a less attractive picture emerge then the authors warn that some of the spread narrowing may, inevitably be reversed.
With all the good news for the buyers during 2003, it should come as little surprise that the sellers, or issuers took advantage of the greatly improved conditions. There was high double-digit gains in issuance in many regions, with Europe again coming out ‘top’ in terms of the acceleration in the pace of new issuance. Interestingly issuance in the Asia-Pacific region declined, although Standard & Poor’s do not believe that this might presage any sort of a decline in investor demand for emerging market securities and instead expect them to remain very attractive particularly as the global economic growth continues to pick up.